Accounting changes and enforcement of bank capital requirements in a crisis

A common response to systemic shocks are accounting changes that reduce the impact of losses on banks’ regulatory capital. We show that these accounting changes can increase banks' incentive to raise capital. Banks trade off the cost of raising equity and the cost of violating regulatory capital requirements. A systemic crisis weakens the enforcement of capital requirements, which reduces banks’ incentives to recapitalize. Reducing the impact of fair value or expected credit losses on banks’ regulatory capital lowers the amount of equity that banks have to raise to fulfill regulatory capital requirements. Banks that have no incentive to recapitalize under initial accounting rules can find it optimal to raise the necessary (lower) amount of equity to avoid regulatory intervention after the relaxation of the accounting rules. We discuss ex ante implications of relaxing accounting rules and differences to relaxing capital requirements.